Discuss the Proposition that a Company's Dividend Policy is Irrelevant to its Market Value - Essay Example

Extract of sample Discuss the Proposition that a Company's Dividend Policy is Irrelevant to its Market Value

Some argue that dividend policy will not affect the wealth of the shareholders, whereas some have the opinion that the decisions about dividend policy will affect the shareholder’s wealth and the firm’s valuation. “Dividend policy refers to the decision regarding the magnitude of the dividend payout, the percentage of earnings paid to the stockholders in the form of dividends. The central, and as yet unresolved, issue concerning dividend policy is whether changes affect firm value” (Dividend Policy 2012). Following are the factors which influence the dividend policy: • Market deficiency for example taxes, agency costs, asymmetric information, flotation costs and transaction costs. • Behavioral considerations for instance illogical shareholder behavior, behavioral desires of shareholders and usual behaviors of firms. • Industry characteristics for example profitability, size, investment opportunities, availability of cash on probable cash flows and future earnings. • Managerial likings for example smoothing of dividends and the disinclination to decrease future dividends. Arguments for the Dividend Irrelevance: Dividend Irrelevance is a theory that an organization’s strategy of dividend has no actual influence on the value of the company. “The main cause for paying or not paying dividends is the cost of tax. Though dividend irrelevance is not absolutely accurate, it is a superior adequate estimate to the certainty that basic assessment should usually do not take into account strategy of dividend” (Expert 2012). The enduring assumption of dividends involves with the aim that if the organization cannot spend its income to make a revisit that is more than expenditure, it must deliver the income by paying dividends to shareholders. “The theory of dividend irrelevance is founded on the basis that an organizations dividend strategy is sovereign of the value of its share value, in addition to the dividend choice is an inactive residual. The price of the organization is resolved by its financing and investment decisions in a best capital formation, and not by its decision of dividend. A general policy of dividend should provide every industry its value of shares, as the policy of dividend is irrelevant in resolving the value of the firm” (Barman n.d., p. 17). This method suggests that dividends symbolize earnings residual more willingly than a dynamic decision variable that influences the organization’s worth. Such a vision is reliable with the theory of dividend irrelevance put forward by the authors Merton H. Miller and Franco Modigliani. “The authors argue that the industries value is ascertained only by the earning risk and authority of its resources, and that the way in which it divides its earnings stream among dividends and internally maintained funds, does not influence this cost. The big variations in dividends increased the value of share. When there is an increase in the dividend, the share prices also get increase and when the dividend decreases, the share price gets reduced” (Gitman 2008, p. 513). An organization fascinates investors whose liking for the stability as well as payment of dividends match with an organization’s solidity of dividends and actual payment pattern. The shareholders wish for constant dividends on the basis of
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Summary

Discuss the Proposition that a Company's Dividend Policy is Irrelevant to its Market Value Dividend irrelevance theory basically signifies that an issuance of dividends must have little or no impact on stock price. This theory is “A postulation that the dividend policy of a company should have minimal effect on the investment decisions made by an investor due to the fact that the payment or non-payment of a dividend will not necessarily impact the net return to the investor…

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